Financial Stability Report 2012/2013 Press Conference Presentation Miroslav Singer Governor Prague, 18 June 2013
Structure of presentation I. Initial state of real economy and financial sector and alternative stress test scenarios II. Credit risk in the sectors of households and nonfinancial corporations III. Property market and government bond market IV. Stress tests and resilience of the financial sector V. Main conclusions and overall assessment of risks 2
I. Initial state of real economy and financial sector and alternative stress test scenarios 3
Balance and intensity of risks The balance of risks to financial stability is little changed from the previous FSR 2011/2012. Downside risks (i.e. towards less favourable developments), stemming from the external environment, prevail. The risks to financial stability in the euro area remain high. Financial markets have stabilised partially and liquidity has been restored even on risky assets markets, But the outlook for real economic activity has worsened further. The current stability in the euro area is very fragile. A resurgence of strong tensions, due to a combination of risks in bank balance sheets, falling economic activity and sovereign risk, cannot be ruled out. 4
Main risks The Czech financial sector as a whole remained highly resilient to external risks in 2012, with some of its parameters becoming even more robust (capital adequacy, client deposits). The main risk scenario for the Czech economy and its financial sector is a more pronounced and longer-lasting decline in economic activity. The adverse income prospects of firms and households are related not only to falling external demand, but also to weak domestic demand. The main risks to the banking sector consist in growth in credit losses and a decline in its ability to generate income to cover those losses. If the recession deepens, banks could face a rapid non-linear increase in the default rate and losses given default. 5
Alternative stress test scenarios (1) With regard to the current situation and to the risks identified, the resilience of the domestic financial system was assessed by means of stress tests on banks, insurance companies and pension funds. The Baseline Scenario is considered by the CNB to be the most probable based on the CNB s May forecast published in IR II/2013. The Protracted Depression stress scenario describes the risk of a long-lasting and pronounced decline in domestic economic activity. It is supplemented in sensitivity analyses with other shocks: adverse financial market developments, write-downs of claims on indebted European countries, collapse of the largest debtors of each bank, and a much deeper recession leading to a significant increase in credit losses in the banking sector. 6
Alternative stress test scenarios (2) Alternativní scénáře: vývoj růstu reálného HDP Alternativní scénáře: vývoj měnového kurzu (v %) (CZK/EUR) 5 3 1-1 -3-5 30 29 28 27 26 25 24 23-7 22 03/10 03/11 03/12 03/13 03/14 03/15 03/16 03/10 03/11 03/12 03/13 03/14 03/15 03/16 Základní scénář Vleklá deprese Základní scénář Vleklá deprese Alternativní scénáře: vývoj inflace Alternativní scénáře: vývoj 3M Pribor (v %) (v %) 6 3 5 4 3 2 2 1 inflační cíl 0 1-1 -2-3 03/10 03/11 03/12 03/13 03/14 03/15 03/16 Základní scénář Vleklá deprese 0 03/10 03/11 03/12 03/13 03/14 03/15 03/16 Základní scénář Vleklá deprese 7
II. Credit risk in the sectors of households and nonfinancial corporations 8
The NPL ratio decreased in 2012, but Despite the adverse economic situation, the NPL ratio in the banking sector decreased slightly last year (and has been fluctuating around 6% since 2010). Growth in NPLs and related provisioning indicate that the inflow of NPLs has accelerated slightly in the last two quarters. Major industries with previously low default rates are sliding into recession. Growth in NPLs and loan loss provisions to total claims (year-on-year change in %) 80 60 40 20 0-20 09/09 03/10 09/10 03/11 09/11 03/12 09/12 03/13 NPLs Loan loss provisions Source: CNB 9
Corporate credit risk in alternative scenarios In the Baseline Scenario the corporate NPL ratio is flat this year and then starts to fall gradually. In the Protracted Depression scenario the NPL ratio rises significantly above the values recorded in 2010 and exceeds 12%. NPL ratio for bank loans in the non-financial corporations sector (%) 14 12 10 8 6 4 2 03/10 03/11 03/12 03/13 03/14 03/15 03/16 Baseline Scenario Protracted Depression Source: CNB 10
The recession is hitting households harder than firms Non-financial corporations are able to partially offset their worse income by cutting labour costs. Households are being hit much harder by the long recession. Falling real gross disposable income (including in the Baseline Scenario) is increasing credit risk in both the consumer credit and loans for house purchase segments. Macroeconomic income aggregates in the Czech Republic in reaction to different scenarios (average year-on-year growth in %) 8 6 4 2 0-2 -4 GDP (nominal) Household GDI (nominal) GDP (real) 2002 2008 2009 2012 2013 2014 Baseline Scenario Household GDI (real) Source: CZSO and CNB forecast Note: GDP gross domestic product, GDI gross disposable income 11
Household credit risk is gradually rising The NPL ratio in the household sector increased only slightly in 2012 despite households worse income situation. Only the consumer credit segment got worse. Stress tests on households indicate substantially higher vulnerability and a rising degree of overindebtedness in all the tested scenarios. Non-performing loans to households (in %) 14 12 10 8 6 4 2 0 10/09 4/10 10/10 4/11 10/11 4/12 10/12 4/13 Source: CNB Households Housing loans Consumer loans 12
Credit risk is being depressed by falling interest rates Despite rising household debt, the ratio of net interest payments to income is flat. Household debt ratios (%) The interest rate component of the credit conditions is thus countercyclical in its effect. The fall in interest rates is reducing debt service costs and the risk of default. However, it may create an illusion of easy repayment (this holds for firms as well). 70 60 50 40 30 20 10 0 2.5 2 1.5 1 0.5 0-0.5 2000 2002 2004 2006 2008 2010 2012 Debt/financial assets Debt/gross disposable income Debt/GDP Net financial assets/gdp Net interest/gross disposable income (right-hand scale) Source: CNB, CZSO 13
Household credit risk in alternative scenarios In the Baseline Scenario the household NPL ratio is also flat and will stay at an elevated level until the end of 2014. NPL ratio for bank loans in the household segment (%) The Protracted Depression scenario implies a sharp rise in the NPL ratio compared to the current situation. 9 6 3 0 03/10 03/11 03/12 03/13 03/14 03/15 03/16 Baseline Scenario Protracted Depression Source: CNB 14
The potential credit losses are rising In the Baseline Scenario almost 60% of NPLs are in the loss loan category at the end of this year. The rise in the proportion of loss loans implies potentially higher credit losses and a need for additional provisioning. The coverage of NPLs by provisions, which has long been constant, may not be consistent with the increased level of credit risk. Structure of NPLs and 2013 forecast based on the Baseline Scenario (%) 100 90 80 2013 70 60 50 40 30 20 10 0 12/07 12/08 12/09 12/10 12/11 12/12 12/13 Substandard Doubtful Loss Source: CNB 15
Interest margins on new loans are very low Interest rates on new loans to corporations and loans for house purchase are at record lows, as are interest margins on such loans. Current credit margins on loans to corporations and loans for house purchase imply lower debt service costs, but may not always be in line with credit risk. Interest margins on consumer credit reflect its high level of risk. Interest margins from new bank loans in the Czech Republic (in pp) 5.0 4.5 4.0 3.5 3.0 2.5 2.0 1.5 1.0 9 03/05 03/06 03/07 03/08 03/09 03/10 03/11 03/12 03/13 Housing loans Non-financial corporations Consumer loans (right-hand axis) 15 14 13 12 11 10 Source: ARAD, CNB`s calculations 16
There are many problems in the credit union sector (1) The balance-sheet total of credit unions increased by 51% in 2012 despite their riskier profile. Credit unions are maintaining relatively high deposit interest rates. This is creating need to grant risky loans at high interest rates. The credit union segment also shows a high concentration of loans provided. Any repayment problems among important clients could jeopardise the stability of credit unions. Selected indicators of credit unions as compared to banks (%; end-2011 and end-2012 data; credit unions active as of 31 December 2012) Average interest rate on client loans (1) Average interest rate on client deposits (2) Credit unions Banks 7.4 4.8 2.9 1.1 Client NPL ratio 9.9 6.2 Quick assets/total assets 14.3 29.1 Coverage of NPLs with provisions 16.4 49.4 Tier 1 CAR 12.3 15.9 RoE 7.5 21.4 Share of sector in client deposits Source: CNB 2012 1.2 98.8 Note: The year-on-year comparison excludes Unibon, whose licence was revoked in March 2012. 17
There are many problems in the credit union sector (2) The aggregate risk indicators are high and increased further in 2012 Q1. Five out of the total of 13 credit unions have NPL ratios exceeding 13%. Coverage of NPLs by provisions is very low. The sector needs to considerably increase the prudence of its business and the quality of its risk management. The CNB will continue to pay increased attention to the situation in the sector and submit suggestions for regulatory changes. Selected indicators of credit unions as compared to banks (%; end-2011 and end-2012 data; credit unions active as of 31 December 2012) Average interest rate on client loans (1) Average interest rate on client deposits (2) Credit unions Banks 7.4 4.8 2.9 1.1 Client NPL ratio 9.9 6.2 Quick assets/total assets 14.3 29.1 Coverage of NPLs with provisions 16.4 49.4 Tier 1 CAR 12.3 15.9 RoE 7.5 21.4 Share of sector in client deposits Source: CNB 2012 1.2 98.8 Note: The year-on-year comparison excludes Unibon, whose licence was revoked in March 2012. 18
III. Property market and government bond market 19
The risks to prices on the property market are on the downside The risks of lower property prices highlighted in FSR 2011/2012 materialised in 2012. The decline in prices and the number of transactions is in line with fundamentals. Property prices are still subject to considerable mostly downside risks. The Baseline Scenario predicts flat or slightly falling apartment prices, with no recovery until 2014. In the Protracted Depression scenario property prices drop by Property price index according to different scenarios (2007 Q4 = 100) 105 100 95 90 85 80 75 70 65 03/10 03/11 03/12 03/13 03/14 03/15 03/16 Source: CNB Baseline Scenario Protracted Depression 17%. 20
The risks to prices on the property market are on the downside Residential property price sustainability indicators improved further in 2002. Apartment prices are most likely close to their fundamental levels. The perceived risk of a further decline in property prices decreased but there are risks of a deterioration in the fundamental determinants of property prices in the long run (the labour market situation and labour incomes, demographic trends, etc..). Price-to-income ratios (ratio of price of 68 m 2 apartment to moving sum of wage over last four quarters) 13 11 9 7 5 3 1 12/01 12/03 12/05 12/07 12/09 12/11 Prague Ostrava + Ústí n. L. CZ total Source: CZSO, CNB calculation Brno Rest of CZ 21
The difference between the rental return and the interest rate on house purchase loans widened The possibility of property purchases as financial investment is opening up. Prices in some regions could become overvalued in the medium term. Such overvaluation could even take the form of a bubble from below, with property prices rising at a modest pace amid worsening fundamentals. Apartment rental returns (averages for period in %; 2003 2006 yearly data, then quarterly) 11 9 7 5 3 1 03/07 03/08 03/09 03/10 03/11 03/12 03/13 Prague Rest of CZ House purchase loan rate Source: IRI, CNB Ostrava+Ústí 10Y yield 22
The credit risk of property developers remains high Despite a relative stabilisation of the property market and a recovery in sales of residential development projects, the NPL ratio in this segment remains high. This contrasts with an asymmetric easing of lending conditions for loans for house purchase and significantly reduced margins on such loans. NPL ratios in the property development sector (%; year-on-year growth for apartment prices) 20 15 10 5 0-5 -10 12/02 10/04 08/06 06/08 04/10 02/12 Source: CZSO, CNB Non-financial corporations Developers NACE 68+411 Selected developers Apartment prices (right-hand scale) 40 30 20 10 0-10 -20 23
The CNB is preparing set of appropriate instruments reacting to the gradual rise in property financing risks Capital regulation tools (e.g. higher sector risk weights). Many countries set a cap on the loan-to-value (LTV) ratio. The aggregate LTV for mortgage loans is relatively low (below 60%) but is rather unresponsive to property prices. However, loans with a high LTV may account for a significant proportion of some banks portfolios. Proportion of property purchase loans provided by the bank to households with an LTV above 100% as of 31 December 2012 (x-axis: market share of bank in %, y-axis: proportion of loans with LTV above 100%) 100 90 80 70 60 50 40 30 20 10 0 0 5 10 15 20 25 Source: CNB 24
The concentration of Czech government bonds in financial institutions assets is rising The share of Czech government bonds in the banking sector s balance sheets increased from 15% to 17% in 2012. The concentration of domestic banks portfolios on the government as a debtor is creating significant exposure to sovereign risk, is increasing the links between the banking sector and the government sector. The current fiscal situation is stable and sustainable but some banks are showing elevated concentration risk. Share of bonds issued by domestic governments in the balance sheet of MFIs excluding central banks (%; MFIs excluding central banks comprise credit institutions and money market funds) 20 18 16 14 12 10 8 6 4 2 0 01/02 05/03 10/04 03/06 08/07 12/08 05/10 10/11 03/13 CZ MFIs EA MFIs CZ banking sector Source: CNB, ECB 25
The current very low bond yields are a source of market risk The flight to quality/liquidity is generating a risk of upward deviations in prices of high-quality bonds Current government bond yields may prove to be unsustainably low in the long term. A large proportion of the bonds held by institutions are in the revaluation-to-fair-value part of the balance sheet. If the market situation were to change suddenly, a decline in the market prices of the securities held would have an adverse impact on profitability. Breakdown of the bond portfolio by sector and valuation method (%; share in bonds; as of 31 December 2012) 100 90 80 70 60 50 40 30 20 10 0 AFS AFS Banks Insurance companies Other held to maturity Other for revaluation Czech GBs held to maturity Czech GBs for revaluation Pension funds Source: CNB Note: AFS denotes financial assets classed as "available for sale". The figures for the insurance sector include financial placement of unit-linked insurance. 26
IV. Bank stress tests May 2013 27
Bank stress test results In the Baseline Scenario two banks fall below the 8% level. They account for just 1% of the assets of the sector as a whole. The stress test methodology assesses their business models as unsustainable from the long-term perspective. In the Protracted Depression scenario 13 banks would fall below the 8% threshold. They account for 17% of the sector s assets. To get their CARs back up to 8% they would need capital injections totalling almost CZK 16 bn (0.4% of GDP). The total CAR does not fall significantly below 12%. Capital adequacy ratios depending on scenarios (%) 18 16 14 12 10 8 6 4 03/10 03/11 03/12 03/13 03/14 03/15 03/16 Baseline Scenario Source: CNB, CNB calculation Protracted Depression 28
Selected sensitivity analyses of stress scenario (1) The Protracted Depression was supplemented by sensitivity analyses. Loss of Confidence leads to a rise in government bond yields and impairment of exposures to indebted EU countries. Impairment of the exposures of the five largest domestic banks to their parent groups is then added. The total CAR falls below 10%. 14 banks would need capital injections totalling more than CZK 31 bn (0.8% of GDP). Capital adequacy ratios depending on scenarios (%) 18 16 14 12 10 8 6 4 03/10 03/11 03/12 03/13 03/14 03/15 03/16 Baseline Scenario Protracted Depression Protracted Depression and Loss of Confidence + impairment of 50% of adjusted exposures to parent groups Source: CNB, CNB calculation 29
Selected sensitivity analyses of stress scenario (2) Another sensitivity analysis on top of the stress scenario assesses the impacts of an even longer recession over the entire three-year horizon with stronger deflation pressures. A sharper fall in household and corporate income leads to a further reduction of consumption and investment. Exhaustion of financial reserves causes growth in the default rate on existing debts. 14 banks would need capital injections totalling CZK 29 bn (0.7% of GDP). The sector as a whole remains resilient even in these highly stressful scenarios. Capital adequacy ratios depending on scenarios (%) 18 16 14 12 10 8 6 4 03/10 03/11 03/12 03/13 03/14 03/15 03/16 Baseline Scenario Source: CNB, CNB calculation Protracted Depression Stronger Protracted Depression 30
Assessment of stress test results The stress tests and other analyses demonstrate that the Czech financial sector is well prepared for potential stresses. Banks have a large capital buffer which enables them to absorb adverse shocks and maintain the sector s overall capital adequacy sufficiently above the regulatory threshold of 8% even in a very unfavourable scenario. To maintain high public and investor confidence in the stability of the Czech banking sector in the current adverse economic environment, banks must maintain a high capacity to absorb potential credit and market losses. 31
V. Overall assessment of the situation and macroprudential policy recommendations 32
Assessment of position in financial cycle The domestic financial sector is currently in a phase of the financial cycle dominated by risks relating to the weak economic activity seen over the last few years. The modest credit recovery observed in 2010 2011 ended with the onset of the recession and demand for loans and risky assets is now subdued. The interest rate component of the credit conditions has eased further and is thus having a countercyclical effect. Increased risk aversion and an absence of optimistic expectations are not creating conditions for increased credit activity reflected in excessive risk-taking. The Czech financial sector faces no risks due to excessive credit growth, and if the CNB had the option of using a countercyclical capital buffer it would set it at zero for exposures in the domestic economy for the next two years. 33
Assessment of internal risks No acute risks to financial stability requiring immediate action were identified. A risk for the Czech banking sector is growth in credit losses as a result of a continued adverse trend in economic activity. Credit risk in banks balance sheets is high and rising. Coverage of NPLs by provisions is low. If the recession continues, a rapid non-linear increase in the default rate and losses given default cannot be ruled out. Banks also face strong downward pressure on stable sources of profit (esp. interest profit and profit from fees and commissions). There are several potential internal sources of systemic risk. Risks linked with lending to property sector are gradually developing. Risks associated with sovereign exposures (concentration risk, interest rate risk) are growing. 34
Assessment of external risks The situation regarding the links between Czech banks and their parent groups has been generally favourable in recent months. Exposures of domestic banks to their parent groups have shrunk, partly due to a change in the regulatory limits set by the CNB in 2012. There are numerous short- to medium-term risks of external origin connected with the microeconomic environment in advanced countries (weak economic activity; search for yield in an environment of low interest rates), the approach of the euro area authorities to crisis resolution (slow recapitalisation and restructuring of banking sectors), some elements of the euro area banking union project. 35
Measures to maintain confidence in banking sector stability The CNB will continue to pay increased attention to the quality of the loan portfolios of banks and credit unions. In view of the increased level of credit risk, the CNB will continue to apply enhanced monitoring in the following areas: prudential categorisation of claims, sufficiency of provisioning, appropriate risk weight setting, correct valuation of collateral. It is particularly important to maintain robust capital buffers in systemically important banks. Given the dominant role of banks in the Czech financial sector and the high concentration of the Czech banking sector, the CNB is ready to apply capital buffers to these institutions in accordance with the new CRD IV/CRR regulatory package. 36
Thank you for your attention Financial Stability Reports: http://www.cnb.cz/en/financial_stability/fs_reports/index.html Contact for the Financial Stability Department: E-mail: financial.stability@cnb.cz http://www.cnb.cz/en/financial_stability/ 37